Treasury Note

A Treasury note is a marketable U.S. government debt security with a term of more than one year and up to ten years. It pays a fixed rate of interest in two installments each year and repays its face value at maturity. Notes are sold at regular auctions and can be bought directly through TreasuryDirect or on the secondary market through a broker. Along with Treasury bills and Treasury bonds, notes are one of the coupon-and-maturity structures the Treasury uses to finance the federal government, and they sit in the middle of that range by maturity.

The Treasury issues marketable securities across a ladder of maturities, and the note occupies the intermediate rungs: 2, 3, 5, 7, and 10 years. Shorter than a note is the Treasury bill, which pays no coupon and is sold at a discount to face value, returning the full face value at maturity. Longer than a note is the Treasury bond, issued in 20-year and 30-year terms. The Treasury also sells inflation-protected securities (TIPS) and floating-rate notes, so a note is one member of a larger family rather than half of a two-part set. What makes the note distinctive is not its mechanics, which mirror an ordinary coupon bond, but its place in the financial system. The 10-year note is the reference point the market uses to gauge the cost of intermediate borrowing. Its yield feeds into the pricing of corporate bonds, influences long-term mortgage rates, and serves as the "risk-free" rate in valuation models. Because it carries the full faith and credit of the United States, analysts treat its default risk as negligible and use its yield as the baseline that every riskier bond's yield is measured against. That does not make a note risk-free in every sense: its price still falls when interest rates rise, which is interest rate risk, and an investor who sells before maturity can lose money even though the government pays every coupon on time.

A Treasury note is bought at auction or on the secondary market, pays a fixed coupon twice a year, and returns its face value on the maturity date.

A hypothetical example. An investor buys a 5-year Treasury note with a $10,000 face value and a 4 percent coupon rate.

• Annual interest: 4 percent × $10,000 = $400 a year.
• Paid as two installments: $200 every six months, for a total of ten payments over five years.
• At maturity: the investor receives the final $200 coupon plus the $10,000 face value.

If interest rates rise after the purchase, newly issued notes pay more, so this note's fixed $400 becomes less attractive and its market price falls below $10,000. An investor who holds to maturity is unaffected by that price move and simply collects the coupons and the face value. An investor who sells early realizes the price change, up or down.

Pros

• Backed by the full faith and credit of the United States, so default risk is treated as effectively zero.
• Pays predictable fixed income every six months over an intermediate horizon.
• Highly liquid and easy to buy, whether at auction through TreasuryDirect or through a broker.
• Interest is exempt from state and local income tax, though still subject to federal income tax.

Cons

• The price falls when interest rates rise, so selling before maturity can produce a loss.
• Fixed coupons lose purchasing power to inflation over the note's life.
• Yields are generally lower than those on corporate bonds of similar maturity, which is the price of the government's credit quality.